SME Event: Expanding Your Business in China Richard Hoffmann Manager, Dezan Shira & Associates

Dezan Shira & Associates – the Asian Practice 20 years in China 12 Offices in China, 5 Offices in India, 2 Offices in Vietnam 2000 clients from 81 countries Provide business incorporation, tax & accounting, legal and HR services www.dezshira.com

Topics Part I: China’s Second Tier Cities What is a Second Tier City? Change of Direction for Foreign Investment Economic Development & Industrial Zones Advantages & Disadvantages Second Tier City Success Stories Part II: How to Structure your Company when Expanding Choosing the Right Corporate Vehicle Addressing Legal and Tax Considerations What to Consider for your China Expansion Plan www.dezshira.com

China’s Second Tier Cities PART I China’s Second Tier Cities www.dezshira.com

Introduction No such thing as one “China market” No market of 1.3 billion people – treat China as a series of regions 160 cities with a population of 1 million or more Europe has 35 cities with a population over one million China’s urban population today is 633 million www.dezshira.com

What is a second tier city? No official definition Key indicators: - Population: 3million+ - GDP RMB 250 billion or more - Strong growth - Transportation - Historical and cultural significance 2nd Tier cities: - Tianjin - Dalian - Qingdao - Nanjing Second tier cities - the future engine of China‘s growth www.dezshira.com

Relative Populations of the largest 50 cities in China Tianjin with 7.46 million people is already bigger than Boston, Madrid, Sydney, or Toronto

Average annual Increase (2000-2010) Population (2010) District City GDP(2010) Average annual Increase (2000-2010) Population (2010) Average annual increase (2000-2010) Bo Sea Tianjin RMB 911bn 17.40% 12.94m 2.60% Qingdao RMB 567bn 12.90% 8.72m 1.52% Dalian RMB 516bn 15.20% 6.69m 1.28% Yangtze River Delta Suzhou RMB 917bn 13.00% 23.02m 3.24% Wuxi RMB 576bn 13.10% 6.37m 2.09% Ningbo RMB 513bn 12.40% 7.61m 2.46% Pearl River Delta Dongguan RMB 425bn 10.30% 8.22m Foshan RMB 565bn 14.30% 7.19m 3.03% www.dezshira.com

Top world cities: GDP 2025 Rank GDP Growth (2007 – 2025) GDP (2025) 1 Shanghai New York 2 Beijing Tokyo 3 4 Tianjin London 5 Chongqing 6 Shenzhen Los Angeles 7 Guangzhou Paris 8 Nanjing Chicago McKinsey Global Institute: Urban World: Mapping the economic power of cities (March 2011)

Change of direction for Foreign Investment Investing in second tier cities - Why? Surging demand – critical opportunity Ten million new Chinese consumers entering the consumer market each year Less saturation, Less competition Favorable policy shifts Government investment Targeted tax incentives Targeted economic & technological development zones “Go Inland” & “Go West” Campaigns Devolving of power to the provinces Lower production costs Better infrastructure www.dezshira.com

National vs. Provincial GDP Targets www.dezshira.com

Economic Development & Industrial Zones Local governments often make deals with economic development and industrial zones to offer unique incentives to attract foreign investment: Preferential policies Better infrastructure Advantageous investment structure Industry focused Competitive tax incentives Reduced/free office rentals & utilities www.dezshira.com

Case Study: Tianjin - Government incentives to attract FDI Attracted investment from over 110 countries and regions 18,000 foreign-funded enterprises have established their branches in Tianjin More than US$55 billion foreign investment 285 of the Fortune 500 enterprises have invested in Tianjin 10 Economic Development Areas: Binhai New Area Dongli Jinnan Baodi Beichen Xiqing Wuqing Jixian Ninghe Jinghai www.dezshira.com

Economic Development Area - Binhai New Area Made up of 3 functional zones: Tianjin Economic-Technological Development Area (TEDA) Tianjin Port Free Trade Zone (TPFTZ) Tianjin Port Development plan aims transform BNA into a multi-functional area Modern services Electronic information Bio-pharmaceuticals Modern logistics Automotive Petrochemicals Metallurgy www.dezshira.com

Binhai New Area – 2011 Statistics First quarter 2011: FDI amount US$3.16bn (80% of the City’s total) Of which US$2.39bn put to use Year-on-year growth: 18.2% FDI into Manufacturing: US$1.57bn Year-on-year growth of 63.4% Import value: US$15.873bn Year-on-year growth of 27.05% Export value: US$9.903bn Year-on-year growth of 18.92% Major Drivers: Improved development policy and fund promotion system Foreign trade linkage development system Binhai New Area introduced: Trade platform Export platform SMES risk protection platform Foreign trade enterprises service platform to serve foreign trade enterprises for the first time www.dezshira.com

Advantages & Disadvantages of second-tier cities Less developed logistics & supply chains Employee availability – “talent crunch” Lack of soft infrastructure (train the gov…) Lack of market transparency Policy instability – uneven & overlapping policies - Lower disposable incomes than first-tier cities - Less sophisticated consumers - Lack of good local partners (Joint-Venture) - Lack of professional support Advantages Growth potential (400 m more urban residents in 2030) Influx of new talent Cheaper production costs Improved infrastructure - transportation Rising purchasing power Unmet demand Special economic zones & incentives Stable workforce Relaxed policy environment www.dezshira.com

Operational Costs: Minimum Salary Tier City RMB/Employee/Month 1st Tier Cities (East, South) Guangzhou 1300 Beijing 1160 Shanghai 1120 2nd Tier Cities (East) Ningbo, Zhejiang 1100 Tianjin 960 Hangzhou, Zhejiang Dalian, Liaoning 900 (Inland) Chongqing 870 Zhengzhou, Henan 800 Xi’an, Shaanxi 760 China Briefing, March 2011: Operational Costs of Business in China’s Inland Cities.

Operational Costs: Factory Rental (2010, Q4) Tier City RMB/Sq Meter/Month 1st Tier Cities (East, South) Guangzhou 19.2 Shanghai 24.7 Shenzhen 26.9 Beijing 41.3 2nd Tier Cities (East) Dalian, Liaoning 11.7 Hangzhou, Zhejiang 11.9 Ningbo, Zhejiang 12.2 Tianjin 23.1 (Inland) Chongqing 12.8 Xi’an, Shaanxi 15.8 www.dezshira.com China Briefing, March 2011: Operational Costs of Business in China’s Inland Cities.

Second Tier Success Stories Tianjin and Chengdu

Second tier success story: Tianjin Tianjin is the birthplace of modern machinery industry and textile industry in China. Advanced technology Great strength in science and technology Rich supply of human resources Core industrial sectors: Information technology Automotive Chemicals Metallurgy Medicine New energy sources Environmental protection Tianjin Dalian www.dezshira.com

Tianjin: Graphical Overview FDI: Average Increase per Year (2005-2010) Tianjin China www.dezshira.com

Second tier success story: Chengdu Leader of “Go West” campaign Fastest growing city in the world (2010) Spearheading the development of western China Abundant natural resources, huge & well-educated labor force, and low labor costs Welcomed 374 new major projects last year Local-central collaborative effort may serve as a model for future urban development in China Chengdu www.dezshira.com

Chengdu: Graphical Overview FDI: Average Increase per Year (2005-2010) GDP: Change from a year ago Chengdu Beijing Shanghai www.dezshira.com

How to Structure your Business when Expanding PART II How to Structure your Business when Expanding www.dezshira.com

Topics Legal Structures Key Advantages / Disadvantages How to restructure your business when necessary www.dezshira.com

Types Of Legal Structures - Strategy Must Follow Structure - Freelancer Representative Office Joint Ventures (JV) Wholly Foreign Owned Enterprise (WFOE) Hong Kong Holdings www.dezshira.com

“Freelancer” Is it possible to hire Chinese employees without having a China-based entity? www.dezshira.com

Representative Office Typical uses Marketing, Research, Liaising Hiring of employees in China (visa, residence permit, working permit) Advantage Incorporation quick and easy to set up (2-3 months) Inexpensive Disadvantage No possibility to issue invoices in RMB (Fapiao) RO example: Sourcing in China www.dezshira.com

Wholly Foreign Owned Enterprise (WFOE) Typical Use Can engage in manufacturing, processing & assembly, services & consulting and/or trade Advantage Direct hiring of employees possible Can issue invoices in RMB (Fapiao) Disadvantage Application & incorporation procedure: 4 -6 months (at least) Standard Problem: Ratio between Registered Capital and Total Investment Important: Exit Strategy, Cash Flow www.dezshira.com

Joint Venture (JV) A Joint Venture in China is an entity involving a Chinese and a foreign party Cooperative JV (CJV) vs. Equity JV (EJV) Why do I need a partner? Legally required Other advantages (Network, sales channels, real estate) Risk: Same bed, different dreams! Proper evaluation of partner company required “Due Diligence” Taxes, salary, property rights Ongoing/regular review of company finances imperative www.dezshira.com

Hong Kong Companies Legal Tax Easy and fast to set up “cheap” Set-up costs Ongoing compliance No “real” office necessary Tax Corporate Income Tax 16.5% (compared with 25% in mainland China) No VAT (17% in mainland China) Dividend distribution could be tax efficient HQ 0% 10% HK Company 5% Mainland WFOE www.dezshira.com

What to Consider for your China Expansion Plan When and How: Restructure for Growth Option 1: Increase presence through multiple RO’s Tax ineffective Option 2: Move from Representative Office -> WFOE/ FICE No “upgrading” possible Set up the WFOE/ FICE, then close RO Higher costs for having 2 offices for a temporary time Potential Tax Benefits Domestic Consumption Think ahead: Have an “exit strategy” It is more complicated to liquidate your entity then setting it up Be in compliance (e.g. taxes!) for liquidating a business Calculate severance payment for employees www.dezshira.com

Overall – A great market www.dezshira.com

Our experience from dealing with 2000 clients tells us: You need to… Do your Due Diligence Focus on your strategy Be in compliance with any legal and tax laws Bring enough money Be careful And over all…. www.dezshira.com

Be Patient www.dezshira.com

Publications Our subsidiary Asia Briefing Ltd. has published legal, tax and investment information since 1999 about doing business in China, India, Vietnam, Hong Kong, and Russia. Magazines Website Books www.russia-briefing.com www.dezshira.com

THANK YOU FOR YOUR ATTENTION! Q & A Richard.hoffmann@dezshira.com Mob: +86 18601318781 THANK YOU FOR YOUR ATTENTION! www.dezshira.com